The US Federal Reserve has temporarily barred the nation’s biggest banks from buying back their own stocks and dividend payments until September 30, 2020, after a recent finding showed that economic slump caused by the coronavirus pandemic could trigger $700 billion of loan losses and push some lenders close to their minimum capital levels. The US central bank has taken this decision to ensure that the financial institutions remain resilient to keep lending to the nation’s struggling businesses during the pandemic-induced downturn.
For the July-September quarter of this year, the Fed has directed the large banks to preserve capital by suspending share repurchases, capping dividend payments, and allowing dividends according to a formula based on recent income. The regulator also asked banks to re-evaluate their longer-term capital plans.
The central bank has capped dividend payments to the amount paid in the second quarter and further limited them to an amount based on recent earnings. As a result, a bank cannot increase its dividend and can pay dividends if it has earned sufficient income.
In recent years, share repurchases have represented approximately 70 per cent of shareholder payouts from large banks, it said.
“All large banks will be required to resubmit and update their capital plans later this year to reflect current stresses, which will help firms re-assess their capital needs and maintain strong capital planning practices during this period of uncertainty. The Board will conduct additional analysis each quarter to determine if adjustments to this response are appropriate,” US Fed said.
The Federal Reserve made this announcement after releasing the results of its latest “stress tests,” which are designed to test the resiliency of the public sector banks, and additional sensitivity analyses that its board conducted in light of the coronavirus event.
“The banking system has been a source of strength during this crisis,” Vice Chair Randal K. Quarles said, “and the results of our sensitivity analyses show that our banks can remain strong in the face of even the harshest shocks.”
In addition to its normal stress test, the US Fed also conducted a sensitivity analysis to assess the resiliency of large banks under three hypothetical recessions, or downside scenarios, which could result from the coronavirus-induced economic downturn. The scenarios included a V-shaped recession and recovery; a slower, U-shaped recession and recovery; and a W-shaped, double-dip recession.
The Fed’s analysis suggested that the 34 tested banks could suffer between $560 billion to $700 billion in aggregate loan losses under the hypothetical downside scenarios. The aggregate capital ratios of these lenders may decline between 9.5 per cent and 7.7 per cent under the toughest scenario, as compared to 12 per cent in the fourth quarter of 2019, the results showed.
“Under the U- and W-shaped scenarios, most firms remain well capitalised but several would approach minimum capital levels,” the Fed said. The analysis, however, does not incorporate the potential effects of government stimulus payments and expanded unemployment insurance.
In its analysis, the Fed also found that the US unemployment rate would peak between 15.6 per cent and 19.5 per cent, as against 13.3 per cent in May.